By Paul Tracy
It pays a yield of 10.5%. And it's one of the most unique dividend payers on the market. It's not a regular business -- it doesn't have thousands of employees or millions of dollars worth of equipment -- and it doesn't have complex operations that take a doctorate degree to understand or track. In fact, I think it's one of the simplest investments on the market. It has only one mission -- take in royalties from dozens of oil wells and pay them out to investors.
As a royalty trust, SDT owns a stake in dozens of wells run by its parent company, SandRidge Energy (NYSE:SD). SandRidge Energy takes care of the drilling, production, marketing, and selling of the oil and gas produced (production is split roughly 50/50 between oil and gas). The royalty trust -- SDT -- is passive in the relationship. It doesn't have to do a thing. In return for the initial investment when it went public, its investors get a cut of all the oil and natural gas sold from the wells.
In the latest quarter, the oil produced from those wells allowed SDT to pay a distribution of $0.82 per unit, giving a forward yield of 10.5% at today's price.
But that double-digit yield is just part of the story...
You see, I picked up shares of SDT for my Top 10 Stocks advisory back in early October (subsequently, I also named the stock as one of myTop 10 Stocks for 2012). I bought the shares at just over $20. Three months later the shares trade above $31 -- a gain of more than 50% in price alone.
I'll admit, a 50% gain in three months -- especially from a stock paying a double-digit yield -- is uncommon. But this trust was seeing a setup that's pretty rare. Remember, the trust's production is half oil, half natural gas. Meanwhile it has hedged about 60% of its projected revenues through 2015. Therefore, you'd expect the trust to move with oil and natural gas prices, but not move as much as those commodities.
But when I bought the stock back in October, SDT had fallen more than both oil or gas during the previous two months. To me, that fall in the trust's shares -- and the subsequent rise -- illustrates one of the most important lessons for making money in the short term with income stocks. You can use the sell-offs in some thinly-traded income stocks to lock in abnormally high yields and see significant capital gains.
Mention income stocks to most investors, and they picture companies like Johnson & Johnson (NYSE: JNJ) or AT&T (NYSE: T) -- enormous companies with millions of shareholders that pay yields usually in the 3-4% range.
But when you start to dig into the income field, you see there is an entire corner of the market that most people don't know about. Take SDT for example -- despite yielding more than 10%, the stock trades 180,000 shares per day. That's what AT&T trades in just minutes.
Why is that important? Since many of these income stocks are unknown to most investors, they trade fewer shares. Just a few thousand people selling their shares can lead to a sell-off and some very attractive prices and higher yields for new investors.
And this is the case with SDT. Despite paying a double-digit yield and having much of its production hedged, the shares fell more than oil and gas prices when the broader market saw a sell-off in September. There was nothing wrong with the stock -- short-sighted investors simply sold whatever they owned to get out of the market. That exaggerated the move down, giving investors a chance to lock in a higher yield and setting themselves up for strong gains once things calmed down. You know the rest of the story.
It's one of the best tricks I've found for making serious gains on high-yield stocks in a short time. The opportunity to buy these dips doesn't happen often -- I see it just a couple of times a year at most -- and it usually comes amid a broader market sell-off. And nothing is guaranteed, even if you buy on a dip.
Disclosure: Paul Tracy owns shares of SDT. StreetAuthority owns shares of SDT in one or more if its “real money” portfolios.